Financial Accounting

FINANCIAL ACCOUNTING

Additional Paid-in (eventually, if you sell stocks at a price higher than

 nominal value).

Net Income (profit or loss)



Liabilities

 Long Term Liabilities

o Loans (if you have to pay in more than 1 year)

 Bonds

 Provisions for employees’ benefits



Current Liabilities

o Loans (1st year)

 Trade payables

 Provisions for risks and charges



*the difference between current and long-term asset is that the first provides benefits just for 12

months.

In fact, an entity shall classify an asset as current when:

1. it expects to realize the asset or intend to sell or consume it in its normal operating cycle;

2. it holds the asset primarily for the purpose of trading;

3. it expects to realize the asset within 12 months after the reporting period;

4. the asset is cash or a cash equivalent.

INCOME STATEMENT:

Income Statement

Revenues

- operating cost

Operating Profit

- financial cost 8

FINANCIAL ACCOUNTING

+ financial revenues

Pre-tax Profit

- taxes

Net Income

An income statement is an accounting statement that reflects the operating results of an entity for a

particular accounting period. Minimum information on the face of the Statement of Comprehensive

Income includes the following:

Revenue

 Finance cost

 Share or profit or losses of associates and joint ventures

 Tax expense

 Discontinued operations

 Profit or loss

 Each component of other comprehensive income

 Total comprehensive income

 Profit or loss attributable to non-controlling interests

 Profit or loss attributable to owners of the parent

 Comprehensive income attributable to non-controlling interests as well as to owners of the

 parent.

N.B. this is an example on how to complete an Income Statement; there are several ways to do it,

also with revenue minus all the costs in just one step.

STATEMENT OF CASH FLOW:

It is for financial analysis, it tries to explain you how the company produces cash, if you have

produce cash using your operating activity, using investments or using financing activities.

It is very important to verify if the cash flow generated from the operating activity is positive (so you

are a health company) otherwise you have to investigate on which activity let you earn cash.

Basically, the statement of cash flow explains how the amount of cash on the balance sheet at the

beginning of the period became the amount of cash reported at the end of the period.

It reports cash inflows and outflows in three broad categories:

Operating activities

 Investing activities

 Financing activities

 9

FINANCIAL ACCOUNTING

NOTES:

Notes are an integral part of the financial statements, containing additional information with respect

to those presented in the statement of financial position, income statement, cash flows statement

and statement of changes in owners’ equity.

Notes provide narrative descriptions or disaggregation of items presented in those statements and

information about items that do not qualify for presentation in those statements.

IAS & IFRS:

International Accounting Standard (old name) now is called International Financial Reporting

Standard: they are international rules, adopted by a committee. We are trying to adopt these rules

all over the world in order to have the same accounting system worldwide. Europe was one of the

first to make these rules mandatory for a large number of firms.

In cases in which local rules are applied, not only changes the structure of a statement but also the

method of evaluation, so it is very difficult to match and compare different companies from different

countries.

IAS 39 was about the evaluation of financial instruments, nowadays it has been discovered that

principle was not perfectly adaptable to the current situation: so, it was deeply changed and at the

moment they are publishing (soon, not yet) the IFRS 9.

IAS 1 according to it, a complete set of financial statements comprises many documents:

A statement of financial position as at the end of the period

o An income statement for the period

o A statement of changes in equity for the period

o A statement of cash flows for the period

o Notes, comprising a summary of significant accounting policies and other explanatory

o information. 10

FINANCIAL ACCOUNTING

Lecture 3 – Accounting Principles, Concepts and Policies

Professor Gromis, Chapter 3 of the book

In the preparation of its financial documents, an entity should provide a true and fair view about its

financial conditions and operating results. Anyway, the concept of true and fair view does not mean

absolute truth about enterprises. For Instance, if I am a family business I will try to reduce my profit

in order to pay less taxes; while if I am a manger in a big company I will try to make happen better

performances in order to raise my wage.

As the concept of true and fair view, there are many other principles and concepts to assist in the

development and review of accounting standards and to assist auditors in forming an opinion on

whether financial statements conform with accounting standards.

The Nature of Accounting Principles (First Part)

Two accounting concepts play ‘a pervasive role’ in financial statements:

• Going Concern: when a company is able to survive for one year; the value of an operating

company is superior to the value of its assets. If I buy an operating company I am buying a

company which value is superior of the sum of its item all together. Is the assumption that

an entity will remain in business for the foreseeable future; by making this assumption, the

accountant is justified in deferring the recognition of certain expenses.

If there is reason to believe that the entity will not be able to continue in business, the asset

should be valued on a cessation basis (so net realisable value).

When financial statements are not prepared on a going concern basis, this fact should be

disclosed. In addition, the reasons for assuming the entity is not a going concern and the

measurement basis used should be explained.

• Accrual Concept: financial statement should be prepared on the accrual basis of

accounting, following the principle that: the effects of transactions and other events are

recognised when they occur (and not when cash or its equivalent is received or paid) and

they are recorded in the accounting records and reported in the financial statements in the

periods to which they relate.

In case of earnings a sale is deemed to have taken place at the point in time at

o which the goods are delivered or services provided and not when the proceeds of

sale are received.

In the same way, costs should be recognized when they incurred – goods and

o services are deemed to have been purchased on the date they are received and not

when payment is made.

The Nature of Accounting Principles (Second Part):

• The Matching Principle: The matching principle refers to the assumption that in the

measurement of profit, costs should be set against the revenue which they generate at the

point in time when this arises.

• Entity Concept: The assumption that the financial statements for an entity represent the

transactions of that entity as a unit in its own right and do not contain any assets, liabilities,

income or expenditure that do not relate to the entity. A business has a separate and

distinct identity from its owners. 11

FINANCIAL ACCOUNTING

• Time Period Concept: divides the life of an entity into time period. Users can assume that

financial period of time, typically one year. What is not sure is when the year begins (i.e.

football teams start the year in September).

• Materiality Concept: the materiality concept affects the presentation and the application of

accounting standards, as it assumes that only material items should be

disclosed/presented in financial statements and accounting standards only apply to material

items.

This responds to the objective of true and fair representation as too much information can

mislead users and is not useful in supporting decision-making processes. For immaterial

transactions is useful to group together into categories that are material.

• Money Measurement Concept and Dual Entry: under this concept the information

provided in the financial statements is expressed in monetary amounts (typically in the

currency of the country where the entity is registered).

The Dual Entry concept assumes that every transaction is recorded twice as it affects two

separate accounts in a set of financial statement in order to keep in balance the accounting

equation between assets and the sum of liabilities and shareholder’s equity.

• Prudence Concept: The assumption that the financial statements have been prepared on

a prudent basis in a manner that there is not included any profit which is not earned,

expenses are complete and not understated; prudence introduces an element of caution

into accounting. It is better that the mistake is oriented to reduce my profit, that make the

company’s position worst: the judge cannot say that I couldn’t catch that performance in

reality. Better more prudence and less optimistic in fact potential revenues are treated in a

different way from potential cost (liabilities); so this concept creates an asymmetry into the

accounting process. We will be able to register only earnings that are sure, while we can

register cost that are also potential (this is a tool to be sure that our Statement is not too

optimistic).

• Substance over Form Concept: the economic substance of a transaction should be given

precedence over the legal form of the transaction (in Italy, unfortunately, often form is more

important). For instance, when you obtain an asset using the leasing tool, which is not

legally yours, under this concept is treated the same as the other assets owned by your

company.

• Consistency Concept: allows the user to look at a set of financial statements and assume

that the same policies, methods and estimation techniques have been used from year to

year. Consistency is important for the objective of monitoring performance over time.

Recognition and Measurement:

Items should be recognised in either the statement of financial position or in the statement of

comprehensive income:

if the item meets the definition of an element of the Framework

 the item meets the criteria for recognition.



It is “the process of determining the monetary amounts at which the elements of the financial

statements are to be recognised and carried in the statement of financial position and the

comprehensive income statement”.

The measurement bases are used to determine the monetary value and many entities use a

combination of these methods for measuring the value of different items:

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FINANCIAL ACCOUNTING

Historical cost (concept)

 Current Cost (market value)